The Great Deformation (126 page)

Likewise, the alternative minimum tax rise of $125 billion was only going to hit households which for years had not been paying their fair share of taxes due to loopholes. Most especially, the pending automatic 8 percent cut (sequester) of defense spending was a no-brainer relative to the insane explosion of defense spending from $300 billion under Clinton to $700 billion at present.

Ironically, therefore, there was good reason for Washington's inertia and its inability to fashion a consensus to avert the cliff. The clownish action of the Senate in the wee hours of New Year's morning in enacting a pork-dripping Christmas tree of tax giveaways was an outrage not because of the manner in which it was done, but because it was done at all.

In truth, with the awful specter of “peak debt” lurking around the corner, the $650 billion per year of spending cuts and revenue increases should have been permitted to go forward because they constituted a rare instance in which meaningful long-term deficit reduction could have been obtained without need for legislative action and the impossible, labored maneuvering required to achieve majorities in our current fractured system. In fact, Washington blew an opportunity to sit on its hands while enabling a permanent $4.6 trillion 10-year shrinkage of the deficit, a meaningful downpayment on the urgently needed return to fiscal sobriety. And it could have been done politically. The wild arm-waving about the fiscal cliff that animated Washington and financial TV did not have much resonance with the Main Street electorate; the unwashed public was more or less resigned to taking its lumps.

By contrast, there can be little doubt that the near hysteria was fomented by Wall Street and its organs and shills in financial TV. After decades of getting its way, Wall Street simply presumed it was entitled to any and all actions by Washington that might avert a recession and thereby keep the stock averages high and the “risk-on” trades prospering.

At the same time, official Washington did not have to be coaxed into doing Wall Street's bidding. K Street was automatically mobilized to defend its tax goodies and DOD contracts. Likewise, the ranks of elected politicians were prepared to bang the deficit lever hard, having received decades of house-training on the notion that the US economy should be propped up with fiscal “stimulus” whenever it “underperformed” its full employment potential.

As a practical matter, economic “underperformance” was taken by GOP tax cutters and liberal spenders alike to mean GDP growth of under 3 percent and unemployment over 6 percent. Since the reality of the American economy fell far short of those vestigial benchmarks, politicians reflexively insisted that the state continue to dispense what amounts to economic waste (e.g., unnecessary defense spending) and unaffordable gifts to the middle class (i.e., the Bush tax cuts) so that the private sector could spend and consume beyond its means; that is, avoid a recession that is inevitable because fiscal retrenchment is unavoidable.

It thus happened that needing to avoid a collision with peak debt, Washington kept racing straight toward it, desperately searching for a political consensus to ensure that Uncle Sam would incur a trillion-dollar deficit for the fifth year in a row. Indeed, the definition of enlightened and courageous policy action had taken on a perverse aspect: statesmanship now consisted of cancelling any and all previously enacted policy measures which
would cause too little red ink.

The symbiosis between Wall Street's petulant Cramerites and Washington's champions of Keynesian tax and spending medications thus came to a flailing and twisted estate. Their bedraggled charge up the $650 billion “fiscal cliff” on behalf of more red ink was in reality a noisy and incoherent repudiation of the very tax increases and spending cuts which they had put into law only a few years earlier to reduce that very same budget deficit. Washington was now not only ensnared in a circular process that would inexorably intensify, but was also slipping into a fatal corruption of the policy discourse that would make fiscal governance increasingly impossible.

The fiscal cliff coverage by the Reuters news service, an unembarrassed megaphone of Wall Street's “recovery” delusions, illustrates the growing incoherence of the fiscal narrative. A news story on the eve of the cliff condemned lawmakers for failing to reach a compromise “to avoid the
harsh
tax increases and government spending cuts scheduled for January 1.”

Harsh? The implication was that the foundation of the US economy was just fine, and that borrowing another $1.2 trillion to keep the party going another fiscal year was a no-brainer. All that was needed was for the politicians to summon sufficient courage to uncork some more red ink.

Accordingly, there was not a hint of recognition that 2013 would mark months forty-two through fifty-four of the National Bureau of Economic Research–defined recovery cycle, and that since 1945 the average expansion had lasted only forty-five months. Even a few years earlier, the Keynesian doctors would have recommended weaning the patient from its fiscal ventilator at this late point in the cycle.

In fact, these pending “harsh” fiscal contraction measures were not some gratuitous roadblock that had been erected by enemies or aliens; that is, arbitrary impediments to the American economy's divine right to permanent prosperity, even if borrowed. Instead, they embodied the trap left by years of national fiscal cheating on a grand scale; that is, Washington's pretense that just one more year of fiscal freeloading would be enough to put the American economy back on the road to self-sustaining growth.

THE NEW NORMAL AND THE NEED TO WEAN THE US ECONOMY FROM ITS FISCAL VENTILATOR

As has been seen, that was a terrible delusion. The American economy had been steadily weakening year in and year out since the turn of the century. As indicated, during the past twelve years real GDP growth has averaged an anemic 1.7 percent; there has been zero net new payroll jobs; and the very best gauge of future economic growth prospects—real business investment in plant, equipment and technology—has expanded a barely measurable rate of 0.8 percent annually.

This is the new normal; it is not a temporary fluke or a transient condition related to sunspot cycles. It most certainly does not betray inadequate application of Keynesian tax-cutting and spending medications. Instead, it reflects an economy that has been stunted by the massive debt overhang thirty years in the making and the vast structural damage that resulted from this national LBO equivalent; that is, the offshoring of tradable goods production, the inflation of domestic costs and wages from borrowing $8 trillion from the rest of the world, and the busted investments strewn around the US economic landscape in commercial real estate, retailing, and lodging and leisure, among others.

In the face of peak debt, sustainable and stable public finance requires that the American economy be weaned from its fiscal ventilator regardless of the GDP growth and unemployment stats. The “fiscal cliff” is thus not a one-time event or accident of the fiscal calendar or a bump in the road owing to a stubbornly slow business cycle recovery. Instead, it is now a permanent fiscal condition and signals that the fifty-year Keynesian joy ride is over.

Rather than habitually and incessantly cutting taxes and boosting spending in order to ameliorate the business cycle and goose jobs and GDP, fiscal policy will revert to a protracted conflagration over the dollars and sense of balancing the budget accounts. Peak debt will force this epochal reversal, but the money-driven politics and statist ideologies of Washington have no capacity to make the turn. Summoned by financial necessity to return to the fiscal postulates of Eisenhower, Truman, Henry
Morgenthau Jr., Herbert Hoover, Carter Glass, Calvin Coolidge, and Governor James Cox of Ohio, too, fiscal governance will have a crash landing. Indeed, as signaled by the initial fiscal cliff fiasco of 2012, the state-wreck of the Keynesian era is at hand.

The instrument of the impending demise, the permanent fiscal cliff, is a perverse consequence of Washington's adoption of the ten-year budget cycle. Until now, the latter has quietly functioned to obfuscate a régime of perma-deficits embraced by the Keynesian consensus in Washington and the perma-bulls of Wall Street on the pretext that the American economy was operating below potential.

Yet the device of a ten-year budget is downright devilish. It sanctions heavy-duty fiscal stimulus in the current fiscal year or two to goose economic performance, while proffering the simulacrum of fiscal responsibility in the out-years through prospective policy measures and assumptions which close the budget gap, at least on paper. But it is now evident that this expedient has put fiscal policy on a destructive treadmill: the “out-year” phase of fiscal retrenchment will never come because the combination of peak debt and the next decade's deluge of baby-boom retirements virtually guarantees that the US economy will never attain “escape velocity”; that is, sustained GDP growth above 3 percent and unemployment below 6 percent.

As each new fiscal year approaches, therefore, the nation's politicians, house-trained on the Keynesian predicate nearly to the last man and woman, will discover that their previous out-year deficit reductions are now “harsh” instruments of “fiscal drag” that threaten to prolong the national economy's “underperformance.” Yet the food fight over which tax increases or spending cuts to defer, or which new temporary stimulus measures to adopt, will generate thundering partisan conflict and recriminations.

The blaring dissonance and daily dysfunction of the failing Keynesian state, in turn, will further undermine confidence and animal spirits in the remnants of the nation's floundering free market economy. In an awful feedback loop, this will pave the way for another economic performance shortfall and therefore another “fiscal cliff” crisis each and every year as far as the eye can see.

THE $20 TRILLION TOWER OF DEFICITS AHEAD

This syndrome should be obvious enough by now. But what is drastically underestimated is the true, staggering size of the permanent fiscal gap. The intensity and persistence of conflict and dysfunction that this will generate on both ends of Pennsylvania Avenue is not even dimly appreciated by
either the politicians or the commentariat. Washington is literally in the grip of a fiscal doomsday machine of its own design.

The starting point for grasping the enormity of the coming fiscal conflagration is a singularly towering number; namely, the $20 trillion of cumulative federal deficits that would occur over the next ten years under the aforementioned “unrosy scenario” (
chapter 27
) and the tax and spending policies advocated during the 2012 campaign by the Republicans and Democrats, respectively. Needless to say, this scenario will not play out in the real world because it would raise the federal debt to $37 trillion, or 160 percent of GDP, by the end of the period (2022).

The sheer dysfunctionality of fiscal governance, therefore, will be generated by the unending struggle over the tax increases and spending cuts that will be needed to forestall the implicit national insolvency built into the current Keynesian fiscal state; that is, the neocon warfare state, the bipartisan social insurance régime, and the Republican religion of low taxes. Yet the reason this scenario is only dimly perceived by official Washington is that the so-called baseline budget forecasts issued by CBO and OMB are essentially economic fairy tales.

These ten-year fiscal projections assume a return to “normalcy” in macroeconomic performance and therefore drastically understate out-year deficits. For example, the January 2012 CBO ten-year baseline for fiscal 2013–2022 assumed that wage and salary income would grow by 5.2 percent annually and that income and payroll tax collections would reach about 39 percent of these earnings by 2022.

Yet this is unaccountable. During the twelve years since 2000, nominal wage and salary incomes grew by only 3 percent per year, and the income and payroll tax take was just 32 percent in fiscal 2012, even after eliminating the impact of the payroll tax holiday. The potential for a massive downside hit to CBO's long-term revenue outlook is thus self-evident.

Were wages and salaries to grow again at only 3 percent during the next decade, for example, income and payroll tax collections would be lower than the CBO baseline by nearly $700 billion in 2022 owing just to economics. Beyond that, it would take protracted, bloody partisan conflict to raise the revenue take from 32 percent to 39 percent of wages and salaries. This implies a 22 percent, or $700 billion, annual tax policy increase from baseline levels. To realize that gain would require the permanent expiration of every single item that stood on the New Year's Eve fiscal cliff, including the Bush rate cuts on all taxpayers; every one of the business, student, and family tax credits; the lower tax rates on capital gains and dividends; the deferral of the massive leap in AMT collections; and much more.

As it happened, most of these massive revenue drains got permanently extended, meaning that the combination of unrosy scenario economics and these eleventh hour tax changes will produce a massive revenue shortfall from the CBO baseline. What emerged from the first fiscal cliff battle, in fact, was a permanent $500 billion per year tax reduction, meaning that the combination of sober economics and revised tax policy will reduce the CBO revenue baseline by $1.2 trillion per year by 2022. The level of partisan conflict that would be needed to close that gap in the years ahead is almost unimaginable, but owing to the looming approach of peak debt there will be little alternative.

This prospect of ceaseless Washington strife over tax raising is not farfetched. In fact, there has already been a real world demonstration of a ten-year CBO error of this same magnitude. Thus, its ten-year outlook for fiscal 2002–2012 projected that federal revenues would reach $3.5 trillion for the year just ended (fiscal 2012), but the actual result was $2.5 trillion. This 29 percent shortfall is nearly identical to the potential 30 percent shortfall from the current CBO baseline for 2022 reviewed above.